Woodside's German deal a milestone in LNG market reform

Woodside chief executive Peter Coleman's conference session on Sunday is likely to include a reminder to governments everywhere that fiddling with the settings that secure very large and very long-term investments is a dangerous game.
TREVOR COLLENS

The "portfolio sale agreement" announced recently by Woodside Petroleum marks another milestone in the increasingly rapid maturation of regional and global liquid natural gas markets, Peter Coleman will tell a Perth gas conference on Sunday.

Woodside has confirmed to The Australian Financial Review that the somewhat unexpected counterparty to a deal that locks in 12 LNG cargoes from March next year to April 2020 is the very big German energy trader, RWE.

While RWE is one of Europe's biggest energy traders, the acquired cargoes are destined for Asian markets, according to Woodside. Nonetheless, the European trader's move to lock-up volumes reveals a growing link between Asian and European players in the LNG market.

"This agreement illustrates further diversification of Woodside's buyer relationships and the increasing interaction between Asia-Pacific and Atlantic LNG participants," Coleman told the Financial Review on Thursday.

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According to Woodside, the LNG acquired by RWE will not be shipped from Australia to Germany but instead will be aggregated into the trader's global pool and will most likely find its way to the growing suite of customer nations in the Asia-Pacific region.

Coleman maintains that this deal is symptomatic of the maturation of the LNG trading and shipping market. The market is becoming more liquid as the customer base broadens and the traditional umbilical between LNG producers and their long-term contract customers is stretched.

That is why Woodside has opened a trading office in the regional trading hub of Singapore and that is why Woodside has grown its shipping capability and that is why it is allowing for subtle annual shifts in the balance of its sales commitments.

Last year, for example, Woodside sold 88 per cent of its production on oil-linked contracts under short, medium and long-term arrangements. The balance of production was sold into more spot markets, where gas is priced by more immediate and commodity specific determinants.

Through the first half of 2017, things ran pretty much to routine, although a bit more gas was being sold under short contract arrangements and less being sent to the spot market. At June 30, some 77 per cent of sales had been made under long-term contract arrangements with 14 per cent on short and mid-term arrangements and 9 per cent on spot.

But as things stand right now, only about 83 per cent of Woodside's expected 2018 production is committed under oil-linked contracts. Presumably, some of that drift will be captured by contract markets by year's end. But Woodside seems increasingly comfortable with the idea that the traditionally bilateral LNG market is becoming more fluid and trading on much shorter term dynamics.

People like me maintain that this transition will eventually lead to LNG being priced on its own unique demand and supply dynamics as opposed to being a convoluted reduction of the oil price.

That is going to require LNG index prices that reflect spot and contract delivery prices and those indices will be based around regional trading hubs. And everything points to Singapore being the most likely place for that to happen in the Asia Pacific.

Ah, but we are leaping way, way ahead of where Coleman will admit to being for the moment.

For the moment, Coleman is comfortable to note that the RWE deal is "a sign of increasing globalisation and liquidity in the market" and that incremental growth of liquidity and cargo flexibility will open new energy markets to LNG producers and traders alike.

From what we understand, Coleman's conference session on Sunday is likely to include a reminder to governments everywhere that fiddling with the settings that secure very large and very long-term investments is a dangerous game. This reminder is opportune not least because his audience will include the Minister for Environment and Energy, Josh Frydenberg, and Minister for Finance, Mathias Cormann.

Coleman's refrain will be familiar to those who have listened to the Woodside boss through the great energy debate. His line is that Australia is short of capital, not energy molecules, and that policy certainty is critical if we are to secure the foreign investment needed to sustain and grow our resource base.

Another refrain familiar to Coleman watchers is his determination that LNG has a range of more discrete uses beyond feeding power stations in North Asia. Woodside's push to fuel the ore carriers of the world is pretty well known. But Coleman has lowered his eyes and Woodside is also pushing to offer LNG as a reliable, carbon-light fuel for the power stations that keep Australian mines running and for the fleets of trains and haul trucks that roll around the Pilbara.

Botten's big wins

While we are talking big gas, hasn't former Woodside quarry Peter Botten had a good week?

On Saturday, Botten sat in the stands of the Oil Search-sponsored national football stadium in Port Moresby to watch the PNG Kumuls pummel Wales in the first game of their Rugby League World Cup.

And just four days later he penned his name to an $US850 million ($1.1 billion) two-step deal that marks the end of his odyssey to manufacture a medium-term oil future from Oil Search's still nascent LNG present.

The first step of the deal, struck with a privately held Denver-based explorer called Armstrong Energy, will see Oil Search pay $US400 million for 26 per cent of a large discovery in the paradigm-shifting oil province called Alaska North Slope.

Step two of the deal allows Oil Search an unfettered call over another 25 per cent of the Nunushuk oil discovery and an even bigger chunk of an adjacent but largely unexplored exploration licence. To complete that move to control of Nunushuk will cost $US450 million.

The deal is structured to meet Oil Search's needs and ambitions.

Botten has proven himself an artful strategist in PNG, where Oil Search became the fulcrum on which value-enhancing alliances between potentially rival LNG projects were forged. By inserting Oil Search into other people's plans, Botten was able to speed progress of the Exxon-led PNG LNG project from its original two-train form to decisions that will see it host four and maybe five trains.

That is why step two of the deal is unfettered. Oil Search can on-sell all or part of the second tranche. If history is any guide (and, in this case it is), then Botten will use that 25 per cent as a lure and, given this winter's appraisal drilling goes to plan, probably make a dollar or two along the way.

The logic of Botten's quest to acquire oil and to eventually settle on Alaska is not hard to fathom.

The LNG business is all about very big numbers. Making money in the export gas business takes a whole lot of certified resource, time and capital. You can grow old waiting to make money in LNG.

But oil is a shorter term game. The Nunushuk discovery was made in 2013 and the well that confirmed the resource was world class and potentially one of the biggest onshore conventional oil discoveries in the US for 30 years was only drilled last year.

The development schedule Oil Search is buying into would see an investment decision by early 2020 and first production in 2024 with a rapid ramp-up to 120,000 barrels a day.

The arrangement balances commodity risk and it reduces country risk even though there are said to be simmering issues with the proximity of the discovery to delicate and protected environments and potentially with the local original peoples.

Botten has decades of dealing with those sorts of delicacies and more, and his conviction has recently been reinforced by his new partners in Alaska. Oil Search was introduced to the potential of Alaska North Slopes by Repsol during discussion about potential alliances in PNG. And, for a whole lot of reasons including cross fertilisation of personnel and potential deals past that never happened, Oil Search was no stranger to Armstrong Energy and its billionaire principal, Bill Armstrong.

"Bill had followed us through the InterOil transaction," Botten said on Thursday. "And he had pitched an asset sale to us a number of years ago, in California, which we didn't pick up. But he did that because he recognised us as a strong local operator."